Stem revenue leaks

A recent report by the Auditor General says that the Government has lost an estimated Rs. 3 billion in tax revenue by way of dishonoured cheques and, despite the rise, there have been no steps taken to address the issue. This is deeply problematic given the need to increase public revenue so that it funds critical social needs but also does not disproportionately affect the poor. 

Currently more than 80% of Sri Lanka’s taxes are collected through indirect means, which means that the heaviest tax burden is felt by the poorest because indirect taxes are often levied on essential items such as food, medication, fuel and transport. Therefore it is necessary for any government to strike a balance between direct and indirect taxes with most countries preferring a 60:40 split. 

The other issue is that taxes are needed to fund universal healthcare, education, housing and other social welfare needs. Taxes also bail out crucial loss making State Enterprises and fund the public sector, which has about two million employees in Sri Lanka. To meet these needs adequately public revenue needs to be at about 14%-15% of GDP but the Government has struggled to meet this benchmark for several years and COVID-19 has made the challenge even bigger.    

The latest Mid-Year Fiscal Position Report 2020, released in July, indicated that fiscal performance is likely to be under severe stress during the remainder of the year, given the local and global shocks of the COVID-19 pandemic. There are also ever-present fears of a second wave, and Sri Lanka’s debt metrics call for strong fiscal management not just in the second half of the year but also in 2021, depending on how the economic recovery moves forward. 

Total Government revenue declined considerably by 20.3% to Rs. 476.7 billion during the first four months of 2020, compared to Rs. 598.1 billion recorded in the same period of 2019. Tax revenue declined significantly by 25.9% to Rs. 408.5 billion in the first four months of 2020, compared to Rs. 551.5 billion in the same period of 2019. 

Total Government expenditure fell by 3.2% to Rs. 930.9 billion in the first four months of 2020, compared to Rs. 961.9 billion in the same period of 2019. However, recurrent expenditure increased by 9.3% to Rs. 820.7 billion in the first four months of 2020, compared to Rs. 750.5 billion in the same period of 2019. 

Given Sri Lanka’s comparatively large public sector and dominance of State Owned Enterprises, it is difficult to stem recurrent expenditure. The additional COVID-19 social welfare demands made on the Budget, such as the Rs. 5,000 hand-out done by the Government for two months during the curfew, has also placed more stress on public finances. These were necessary and part of the Government’s responsibility, but they also ran contrary to the fiscal consolidation measures and other reforms that would have kept Sri Lanka’s Budget on a more sustainable path.

The Central Bank Annual Report 2019 released earlier this year counselled the Government to ensure measures are initiated to strengthen Government revenue mobilisation, particularly in the context of renewed risks to economic recovery amidst the widespread COVID-19 outbreak and its adverse impact on fiscal policy and debt sustainability in Sri Lanka. 

Given this set of circumstances not only should the Government be blocking any leaks in the Inland Revenue Department, it will also need to look at fresh revenue measures to put the economy on a sustainable path.